Question: You learned about the difference in risk on various projects, and thus, in the required rates of return. However, it is difficult to measure a

You learned about the difference in risk on various projects, and thus, in the required rates of return. However, it is difficult to measure a projects risk (hence, to adjust the cost of capital for capital budgeting projects with different risks).

Assume a firm uses the one hurdle rate to evaluate all potential projects. Consider two possible cases: (1) The cost of capital for a project under consideration is actually below the firms hurdle rate, and (2) the cost of capital for a project under consideration is actually above the firms hurdle rate.

In each case, can you discuss what happens to the valuation process, and in which direction can capital budgeting be erroneous?

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